Annuity - Meaning, Benefits and Types

 

For individuals looking to plan for retirement, there are a variety of options. Annuities are one of them. An annuity is an insurance product that pays out regular income. It is often used as part of a retirement portfolio.

What is Annuity?

An annuity is a long-term investment agreement between an insurance company and an individual in which the individual makes payments in series or in a lump sum, in exchange for which he gets periodic disbursements or income, either immediately or in the future.

Annuities serve the purpose of providing a regular stream of income when an individual is either faced with unemployment or has retired. Annuities can be tailor-made to suit the specific needs of individuals. Broadly, annuities come in two different forms - immediate and deferred. Deferred annuities are of three basic types - fixed, variable and indexed. Not only can you choose the form of annuity, you can also select how you wish to receive your payments. You can choose the immediate option, where the disbursements are made within a short period of time or you can go for the deferred option, where the disbursements are made after a certain number of years in the future.

In case of your death, the annuity benefits automatically percolate to the nominee you selected initially. Withdrawals from an annuity, however can be made only under specific conditions. The minimum age for an individual to start an annuity is usually 30 years while some have a maximum of 85 years, some don’t have a max limit. Read the contract thoroughly before going in for an annuity plan. See that the fees and all terms and conditions are stated boldly and correctly, not in fine print. Look at other aspects such as surrender charges, penalties, administrative fees etc, just as you would in a regular life insurance policy.

How do Annuities Work?

1. The individual begins by making a lump sum investment in the annuity plan
2. The annuity then makes payments to the individual on a future date or series of dates. The income can be doled out monthly, quarterly, annually or even as a lump sum payment.
3. The income payout is determined by a number of factors, including the tenure of the annuity.
4. The individual can opt to receive the income payments for the rest of his life or for a fixed period of time.
5. The income depends on whether he has opted for a guaranteed payout (fixed annuity) or a payout stream determined by the performance of the annuity's underlying investments (variable annuity).

Different Types of Annuities

Annuities can be broadly classified into two categories - immediate and deferred.

• Immediate annuity:

  In an immediate annuity, there is very little time difference between the accumulation phase and the disbursal phase. The period when the annuity policy holder makes his/ her premium payments is known as the accumulation phase. The disbursal phase is when the annuity payouts are being made to the policy holder. In the case of immediate annuity, the payouts are made out immediately as per the terms and conditions of the annuity policy.

• Deferred annuity:

  Deferred annuity is the exact opposite of an immediate annuity. In deferred annuity, there is a significantly long gap between the accumulation phase and the time the policy holder gets his/her payments annuitized. Due to a longer accumulation phase, payouts in a deferred annuity scheme start from a future date and not immediately.

Who Buys Annuities?

In an annuity, payouts are made to the policy holder after he or she has paid a certain number of premiums. These premiums can be paid either in lump sum or in monthly installments. These payouts are useful as they provide a source of income when one retires or stops having a regular income. This is why the bulk of persons buying annuity policies will be mostly either approaching retirement or already retired.

It is a good idea to buy annuities when you are younger because you get value leverage. You are also in a better position to absorb any negative impact and have enough leeway to change course. Though aspects like tax, and interest rates may take away the sheen of annuities, financial planners recommend buying annuities in small doses. They also view the lack of liquidity in an annuity as positive as it helps to keep the retirement corpus of the policyholder intact. Annuities are also easier to buy than life insurance because you do not need to go through the rigmarole of getting medically examined for health issues.

What Are Tax Implications Of Annuities?

Annuities are supposed to be good investment avenues which provide steady and regular stream of money to the dependents. From the tax perspective annuities as such do not have any tax liabilities until withdrawals or payouts are made. Individuals can choose to get their payouts for life or for a limited duration. The annuity payouts are determined by various factors such as age of investor, what kind of deferred annuity has been chosen, time period of investment, etc. At the accumulation phase under a pension plan, that is when the policyholder is paying his or her premiums, no other tax is levied apart from GST. But at the vesting stage, amount paid in commutation of pension is exempt from tax. However when the payments are getting annuitized, taxes may be imposed based on the applicable Income-tax law.

According to the current Income-tax law, annuities are considered as income and accordingly added to your gross income. You are taxed according to the applicable slab rate. It should be borne in mind that annuity returns are not taxed as capital gains.

Example of an annuity

A Pension Guaranteed Plan or an Immediate Annuity Plan are good examples of an annuity in India.

An Immediate Annuity Plan is a non linked traditional annuity plan that offers you various annuity options and provides you an opportunity to live life on your terms even after retirement.

It gives you guaranteed income for as long as you/your partner lives at a frequency of your choice - monthly/quarterly/half-yearly/annual options. You can benefit from higher annuity rates at investment of Rs 2,50,000 or higher. There is also a death benefit that accrues on certain annuity options that provide for return of purchase price or annuity to your spouse.

On the other hand, Pension Guaranteed Plan is a single premium annuity product which provides a regular guaranteed income for lifetime. You can opt for this kind of an annuity by choosing the purchase price that you wish to pay to buy annuity or choose the annuity amount you wish to receive. You then choose your annuity payout frequency€“ monthly, quarterly, half-yearly, or yearly and then start receiving your annuity payouts through direct credit to your bank account.

Frequently Asked Questions (FAQ)

1. How does an annuity plan work?

   • Annuity plans are pension products, they are opposite of a life insurance policy. If you want to invest your hard-earned money to meet long-term retirement needs, then an annuity product may be the answer.
   • In an annuity plan, a person pays either a lump sum amount or regular instalments in the given period to get regular payments or payouts as long as he/she lives or for a pre-specified fixed period. 
   • The insurance companies invest your money and pay back the income generated as payouts when you retire. The annuity plan covers your financial risk by helping you get a regular payment in your sunset years for a comfortable living. 

2. When should I buy an annuity?

   If you want the annuity payments to start immediately, you can opt for ‘immediate annuity plan’. But, if you need your regular pension payments to start after a specified period (usually after retirement), you can choose a ‘deferred annuity plan’ among other options but you can buy an annuity plan as early as the age of 45 or 50 years but the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout.

3. What is the rate of return in an annuity?

   The rate of return on annuities differ depending on the annuity plan you choose to invest in. One of the popular options is ‘life annuity’ whose return price works like an FD where the investor will earn an income for life, and the nominee gets the amount on the death his/her death. The annual payout on this variant turns out to 5.7-6.4% of the purchase price for someone who is 60 years old. You can also opt for the lifetime annuity, without the return of the initial investment. The interest rate is 7.6-8.1% per annum which is the highest among all variants as the investor does not need to return the funds to an appointed nominee.

4. How much do I need to invest in annuity?

   There is no limit on the amount that you need to invest in an annuity. Whether you choose a deferred or immediate annuity, there are few things you need to consider: 

   • Your actual financial needs
   • Your long-term financial goals
   • Your current savings/investment portfolio
   • The impact of inflation.
   • The alternatives available to you

   For instance, If at the age of 60, Rs 30,000 is sufficient for your monthly expenses, then by the time you turn 80 you will need at least Rs 1,16,090 per month to maintain a similar standard of living at an average inflation rate of 7 per cent.

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